Sensitivity analysis changes one forecast assumption at a time to see how much the result moves, and the switching value is the change that would turn the answer from yes to no. Scenario analysis changes several assumptions together to describe a plausible upside, base and downside case. Presented well, both show decision makers which assumptions really drive the forecast and how much headroom there is.
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Why test a forecast at all?
Every budget, cash flow forecast or investment appraisal rests on assumptions about prices, volumes, costs, timing and interest rates. A single figure hides how fragile those assumptions are. HM Treasury’s Green Book (2026), the government’s appraisal guidance, puts it plainly: sensitivity analysis tests how changes in key assumptions might affect the results and helps show how outcomes might vary if things do not turn out as expected. It requires, at a minimum, sensitivity analysis and switching values for the preferred option, included in the presentation of results.
The Green Book also warns about optimism bias, the demonstrated tendency for appraisals to be over optimistic about costs, benefits and timescales. It tells practitioners to adjust for it explicitly at the outset by increasing cost and time estimates and reducing benefit estimates. Private businesses are not bound by the Green Book, but the lesson carries over: testing against a deliberately cautious case is more honest than presenting the hoped for case as the plan.
How does sensitivity analysis work?
- Build a base case model with each key assumption in its own input cell.
- Pick the assumptions that are both uncertain and influential: usually selling price, sales volume, the main input cost, wages, the timing of a contract and, for longer projects, the discount rate.
- Flex each one by the same amount, for example 10% each way, holding the others at base.
- Record the effect on the measure that drives the decision: profit, minimum cash balance, covenant headroom or net present value.
- Rank the results. The assumptions that move the answer most are where management attention and further research should go.
The weakness is that assumptions rarely move one at a time. A recession lowers volume and price together. That is the job of scenario analysis.
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What is a switching value?
The Green Book defines a switching value as the value a key variable would need to change to so that an option stops representing value for money. In business terms, it is the break point: how far can sales fall before profit reaches zero, or how much can costs rise before the project’s NPV turns negative?
The calculation is usually simple. For profit, divide the base profit by the total the assumption affects. For an investment, divide the NPV by the present value of the cash flows driven by that assumption. For example, a machine costing £50,000 with savings of £15,000 a year for five years has an NPV of £6,862 at 10%, and the present value of the savings is £56,862. The savings can therefore fall by 6,862 ÷ 56,862, about 12%, to roughly £13,190 a year, before the project no longer pays its way. Switching values are often more useful to a board than a list of percentages, because people can judge directly whether a 12% shortfall is likely.
How does scenario analysis differ?
Scenario analysis changes several assumptions at once to describe a coherent story. The Green Book describes it as examining a range of plausible future outcomes and considering the proposal under each one, and notes that for low cost, low risk proposals simple what if questions may be enough. A typical small business set is:
- Base case: the most likely outcome, the Green Book’s central estimate.
- Downside: a realistic bad year, such as losing a large customer, slower collections and a supplier price rise together.
- Upside: what happens if a new contract is won, including the extra working capital and staff it would need.
- Severe but plausible: for lenders and going concern, a case that tests whether the business survives rather than whether it hits target.
Where probabilities can sensibly be attached, an expected value can be calculated by weighting each outcome by its probability, as ACCA’s performance management articles show. Treat those probabilities with caution: both ACCA and the Green Book observe that real world probabilities are often subjective, and the Green Book notes that analysis built on estimated probabilities can introduce spurious accuracy.
What does a worked example look like?
Illustration only. A manufacturer budgets 10,000 units at £50, variable cost £30 a unit and fixed costs of £150,000, giving contribution of £200,000 and profit of £50,000.
| Assumption flexed adversely by 10% | Budget profit (£) | Change | Switching value (profit nil) |
|---|---|---|---|
| Selling price down 10% | 0 | minus 100% | Price down 10% |
| Variable cost up 10% | 20,000 | minus 60% | Variable cost up 16.7% |
| Volume down 10% | 30,000 | minus 40% | Volume down 25% |
| Fixed costs up 10% | 35,000 | minus 30% | Fixed costs up 33.3% |
Price is by far the most sensitive assumption, so any planned discounting needs scrutiny. Combining a 15% volume fall with a 5% rise in variable cost as a downside scenario leaves profit of £7,250; an upside of 10% more volume gives £70,000. The volume switching value is the same idea as the margin of safety in break even analysis.
How should the results be presented?
- Lead with the base case and range. The Green Book suggests the simplest presentation is a central estimate with a range around it, explaining the assumptions behind both.
- Rank the sensitivities. A table or bar chart ordered from most to least influential (often called a tornado chart) shows at a glance where the risk sits.
- Show switching values in plain words. “Sales can fall 25% before we make a loss” is clearer than a grid of figures.
- Show cash as well as profit. A downside that stays profitable can still breach an overdraft limit if debtors stretch.
- Say what management would do. A downside scenario is more credible when it shows the cost cuts or financing that would follow.
Do the accounts or the auditors require it?
For statutory accounts, FRS 102 paragraph 3.8 requires management to assess whether the entity is a going concern, looking at least 12 months from the date the accounts are authorised for issue, and paragraph 3.9 requires disclosure of material uncertainties. Downside scenarios are the natural evidence for that judgement; see going concern assessment. Paragraph 8.7 separately requires disclosure of key assumptions and other key sources of estimation uncertainty that carry a significant risk of material adjustment to assets and liabilities within the next financial year. In valuations, ACCA’s business valuation guidance recommends sensitivity analysis to check that a value is robust; see business valuation methods.
What mistakes come up most often?
- Flexing assumptions that are easy to model rather than those that are genuinely uncertain.
- Using a downside so mild that it is really a second base case.
- Ignoring links between assumptions, such as higher volume needing more stock and debtors.
- Presenting dozens of scenarios with no conclusion.
- Rebuilding the model for each scenario instead of switching inputs, which invites errors.
- Never comparing actual results with the scenarios later, so the business learns nothing about its own forecasting bias. Monthly management accounts are the place to do that.
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Related Accountapedia entries
- Fixed, variable and semi variable costs
- Flexed budgets explained
- Contribution margin explained
- Financial projections for a business plan
- Pricing methods: cost plus, value and competitive pricing
Sources
- GOV.UK: The green book 2026
- ACCA: The risks of uncertainty
- Financial Reporting Council: FRS 102 September 2024 tmKYWO6
- ACCA: Business valuations
Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.